How Do Financial Constraints and Financial Crises Matter in Cash Management?: Evidence From Developing Asian Economies

Introduction

Modigliani & Miller (1958) mention “there is no information asymmetry” and “there are no transaction costs”. However, the literature of corporate finance literature grows extending by relaxing Modigliani & Miller’s both irrelevant proposals. Cash management is directly related to financial constraints. Specifically, financial constraints may arise from information asymmetry and transaction costs. Thus, both information asymmetry and transaction costs may increase in the time of financial crises.

Specifically, the 1997-1998 Asian financial crisis (AFC) has profoundly affected Asian economies, developing ones in particular. Song & Lee (2012) shows firms in East Asian countries give a response by increasing holding cash in the aftermath of the AFC. Then, the global financial crisis of 2008-2009 (GFC) also severely impacted companies across the globe. However, the question of how do financial constraints and financial crises, the AFC and the GFC, matter on cash management in developing Asian economies has not been adequately explored by the literature yet, so, this chapter aims to fill this gap in the literature.

To date, while some research has analyzed the association between financial constraints and cash policy of East Asian firms (Song & Lee, 2012) during and aftermath of the AFC, no single study exists which empirically examines this relationship before and after both the AFC and the GFC across developing Asian economies. Specifically, this chapter first reviews the discussions of financial constraints and cash holdings in the context of financial crises, the AFC and the GFC. Then, this chapter empirically assesses the question of how the AFC and GFC, as well as financial constraints impacted cash management across 26 developing Asian economies, between 1991 to 2016. In the last three decades, Asian firms have encountered two financial crises. First, the AFC arose between 1997-1998, harming companies in all Asian economies, but notably, those are financially constrained ones. Later, the GFC hits the world economy in 2008-2009, greatly influencing the Asian economies again. These two recessions offer an exclusive prospect to assess the impact of financial constraints in the time and aftermath of downturns.

Employing fixed effects, which overcome unobserved heterogeneity, the findings show that financially constrained firms have lower cash before the AFC, they increase their cash level more after the GFC. Multivariate results also confirm univariate results which are in line with both precautionary motive and transaction motive of cash holdings. Namely, the explanatory of power both motives does not work in pre-AFC, but it works in the aftermath of the GFC.

The contribution of this chapter is manifold. First, the influence of financial constraints on cash holdings is firstly analyzed among developing Asian economies. Second, this chapter presents robust results by employing three measures of financial constraints, which are the Whited-Wu index, firm size and dividend payouts. Third, this research may introduce a projection to understand the future status of the world economy considering the association between financial constraints and cash holdings in post-Covid-19.

The findings of this chapter also have important implications for developing economies. First, managers should count the impact of financial constraints and financial crises on cash holdings. Next, investors should consider financial constraints, firm size and dividend payouts of firms when and where to invest in. Then, policymakers should support financially constrained firms in time of recessions like Covid-19. Last, practitioners and researchers should consider the role of the AFC and the GFC on cash holdings and extend the literature with the Covid-19.

The rest of the chapter proceeds as follows: the section of controversies in the literature develops the theoretical framework by presenting the role of financial constraints on cash holdings. Then, this section introduces and assesses the empirical literature on the association between financial crises, financial constraints and cash holdings. After, the research question is indicated. Then, the section of methodology and data introduces panel methods, empirical models for this chapter and data set. After, the section of empirical results shows and evaluates both univariate and multivariate analyses. Finally, further research directions recommend the possible research, and the conclusion concludes the chapter.